Is Your Startup Stuck? How to Get
Real About Restructuring.
With many options under water and return targets missed, entrepreneurs and their investors are facing a harsh reality. But it doesn't have to end badly if everyone is willing to share the pain--and the future gain.
BY HOWARD TULLMAN, GENERAL MANAGING PARTNER, G2T3V AND CHICAGO HIGH TECH INVESTORS@HOWARDTULLMAN1
After a decade of strife
and struggle following the Great Recession and then enduring three more
thankless years of largely treading water through the pandemic, millions of
founders, funders and key company executives and employees are all reaching a
critical point of re-examination of their careers, their family lives, and
their opportunities and alternatives. The extravagant valuations, feverish
expectations and absurdly optimistic timelines, which so many of them
wholeheartedly subscribed to, have all turned into so much dust and despair.
There’s a new sense of
practicality and cynical realism. Patience and perseverance have their limits
and have been sorely tested over the last few years. Today there is increasing
pressure to address and resolve the two most important questions: what’s next
and what can my company offer me as a reason to stick around?
Options granted 10 years
ago are expiring or already gone and even the most committed grantees aren’t
seeing future prospects sufficiently encouraging to even exercise in-the-money
options. Cash out of pocket is the last thing anyone is looking to provide
these days (there’s a strong feeling in some cases that it might be “good money
after bad”) and cashless exercises have multiple issues: (a) they permanently
shrink and concretize the modest financial results of all the effort to date;
and (b) they may have adverse and immediate tax consequences as well for the
employees who do exercise. Other deferred comp vehicles and incentive
schemes are likely well under water and unlikely to recover or improve soon
given the overall reductions in valuations in most marketplaces. A reasonable
assumption is that a couple of additional years of hard work and good fortune
might get the company back to the valuation levels of their last funding round.
On the other side of the
equation, funders and lenders sitting on startup boards and comp committees
aren’t in any hurry to help their portfolio companies revise employee
compensation since they have serious performance and accountability issues of
their own. The IPO window, especially for tech businesses, remains closed;
traditional venture funds are finding it difficult to raise new funds (apart
from A.I. ventures) because their IRR numbers are so poor (as a result of the
Covid “timeout”) and because they have had very few successful exits of
existing, long-in-the-tooth companies to cite as evidence of their ongoing
vision. The M&A transactions that are happening are likely to be seen as
fire sales and shotgun weddings.
Entrepreneurs--admittedly
among the world’s most optimistic individuals -- even find themselves somewhat
uncomfortable asking their people to sign up for another few years. The
founders know they'd be telling the team to accept the likely prospect that
even at the end of the next tranche of pain, scarce resources and stress, the
once-promised pot of gold will have shrunk to levels of reward and return that
may pale next to the compensation of those poor “suckers” who took day jobs
with big banks and consulting firms.
Ordinarily, at this point,
I’d offer some concrete suggestions that we’ve employed in our dozens of
portfolio companies. But the reality is that every single case is one-off at
this point -- totally dependent on the company’s history, the number of key
players involved, prior plans and programs, the amount of available and
unallocated options and shares, and the board’s and investors’ appetites in
aggressively resolving the problem. But in every case, the key is to try to be
pre-emptive, not reactive.
My own belief is
that the only kind of solution that will succeed is a bold and sizable reset in
which the investors make a strong new commitment to the team (forgetting all
the past history) and treat the new allocations of ownership (current and
prospective) as if they were funding a fresh, new enterprise. This means a lot
more work, conversation and negotiation than simply trying to further cram down
management’s share of the business. If all of the parties don’t strongly
believe in the company’s future, there’s no reason to start down the path with
half measures, grudging give-ups, or too lengthy vesting schedules.
What always surprises me
in so many of these discussions is that the exact same investors and lenders
who are making new deals with totally untested managements and unproven ideas
are so often reluctant to re-up with the management teams and businesses they
know. That have a track record. They’d rather back a fresh deal with two
newbies in a garage with a glimmer of an idea than a time-tested team that’s
slowly built a real business. You can call this reluctance sour grapes or
avoiding embarrassment with their partners, but whatever you call it, it’s
clearly a substantial impediment to getting the right resizing of the business
accomplished. You can almost certainly guarantee with this approach that there
will be a further “too little, too late” failure down the line.
But if everyone’s
onboard and willing to work at it, let me offer a couple of philosophical
observations because how you go about the process and how you arrive at the
final deal are far more important than the actual numbers and dollars involved.
(1) New
Game, No Blame
There are plenty of
excuses, rationalizations, and explanations, along with a boatload of blame to
go around. But looking backwards and finger-pointing won’t help. Things didn’t
work out as planned or expected, no one anticipated a once-in-a-lifetime
pandemic. Now it’s all about moving forward.
(2) No
Lessons, No Lectures
Everyone needs to
understand and acknowledge the mistakes and miscalculations that were made, but
no one needs their nose rubbed in it. Don’t expect extensive apologies from
team members who’ve been busting their butts for years to build the business.
None of this should be news to the investors or the board.
(3) It’s
a Fact, Not a Favor
Start from the
proposition that these changes are in everyone’s best interest -- not a
favor, not a concession, and not a contest or competition. The goal is to
best position the business, the investors, and the key team members for success
and then get moving.
(4) Everyone
Satisfied, Not Happy
It’s a given that
there’s not going to be enough to go around and please everyone; that’s an
unrealistic objective to begin with. An arrangement that’s fair, focused on the
right incentives and behaviors, and equally distributed among the parties
is the goal. This is not about near-term winners or losers. Everyone’s in the
same boat.
(5) Leave
a Nibble for Later
Each party should plan
on leaving a little something on the negotiating table. Shared pain is an
important part of the process. Saving a little stash
and conserving some ammo for future adjustments are
usually prudent approaches.
I realize that a lot of
this is intangible in some ways, but I would cite Eminem, a world-class
authority on matters such as these, who said: “I can’t tell you what it really
is, I can only tell you what it feels like.” Make it feel fair and shared and
all the rest will take care of itself.
